Is Smart Beta giving Passive a run for the money?

22 August 2018

Passive managers may be about to lose their swagger. Much of the institutional market has been convinced that passive investments are far more worth the reasonable costs of management than any active fund in the market. The shift to passive has been so dramatic that some economists and market experts are fearful that efficient markets may have all but disappeared, with shares of many companies on passive investment life support.

Smart
Beta and Factor Investing funds are challenging the "passive is
better" theory. Smart Beta funds discard market capitalization to select
stocks, instead using factors, such as value, momentum, risk, cost, and a
plethora of other criteria to re-balance and invest in an index. The result is
an index, but one which changes according to the criteria and invests in only
assets that meet it. On a short term basis, many of the factors are in line
with their passive cousins, but over longer periods, Smart Beta funds have
shown better performance. At a slightly higher management cost than
passive funds, Smart Beta is giving passive managers a run for their money. And
like anything new that works and doesn't cost the Earth, new Smart Beta
funds are popping up everywhere, with demand on the rise.

In
a recent conversation with BlackRock, one of their iShares representative
explained that they project that Smart Beta will represent $1.4 trillion in
assets globally by 2022. With so many fund managers entering this
market, investors will be spoiled for choice on factor strategy indexes.
Much like with passive indexes, the competition among asset managers will be
fierce, as the popularity of Smart Beta continues to rise.

The
passive investing segment of the market is surely watching this trend and
preparing for battle. Whether or not the "passive is better" phenomenon
will be crushed has yet to be seen, but I'm sure active managers on the
sidelines are happy to see the increased competition for their arch-rivals.

What
happens from here will be interesting, because one cannot help but wonder if
factor investing and Smart Beta will replace index investing. After all, why
just get exposure from beta when you can get "smart" beta?